Exploit the success of top funds but pay lower fees, says Emma Simon
These collective funds are like unit trusts but have the advantage of charging lower fees. Most unit trusts or open-ended investment companies (Oeics) charge a standard 1.5pc annual fee. In contrast, the annual fees on investment trusts are closer to 0.6pc. Not surprisingly, as less of your money sticks to the fund manager's shovel, there is more to invest in the assets of the fund, so boosting overall performance.
According to statistics compiled by Money Management , a monthly magazine for financial advisers, investment trusts show a "clear performance advantage" over unit trusts, across most sectors and most time periods.
So why aren't most people's Isa portfolios chock full of these? The fact is these investment trusts aren't as widely bought as unit trusts, mainly because the lower-fee structure means they haven't paid commission to advisers, so they tend not to make it on to "best-buy" lists.
But this looks set to change, following new rules which effectively ban investment advisers from taking commission from product providers. This should put investment trusts on a level playing field with Oeics.
It is important to understand the key difference between unit and investment trusts. Although both invest in a broad range of shares they are structured very differently.
An investment trust is basically a company that is listed on the stock market. Rather than manufacture widgets, or sell burgers, its job is to invest in other companies, and if these investments prove profitable it returns the proceeds to its shareholders.
Like all companies, it issues just a fixed number of shares, hence it is often known as a "closed" fund. In contrast, a unit trust can issue more units, or cancel them, if there is a mismatch between buyers and sellers.
This means that with a unit trust the price of the units you hold is directly related to the value of the underlying fund. So if the fund rises 0.5pc in value, so should the value of your units. But this isn't always the case with investment trusts. Because there is a fixed supply of shares but fluctuating demand for them, there can be a mismatch between the price the shares trade at and the value of the assets held by the trust.
Strong demand for shares will push up prices. Investment trust shares are said to be trading at a "premium" if you buy them for more than the underlying value of the fund. The reverse often happens, too, with shares trading hands for less than the value of the trust's assets.
This can be an advantage to investors: if you are looking to buy, say, Alliance Trust, which is currently trading at a certain percentage discount, you effectively pay less for each £1 of assets bought. If the underlying investments perform well, creating more demand for the shares, this discount should narrow, which means you have made a healthy profit. But remember the reverse can also happen: a large discount could mean this sector is out of favour and could widen further.
So, given there are many investment trusts to choose from, where do you start? A good place for the novice is the "generalist" sector. Many of the oldest and most established trusts fall into this sector, and they are primarily designed as "core" holdings, investing a diversified spread of blue-chip shares, often from across the globe.
Most also offer Isa plans, which enable investors to invest a relatively small amount of money, or set up a regular savings plan.
Investment trusts are also ideal holdings for those looking for an income. Incredibly, some 15 investment trusts have managed to raise or maintain dividend payment for more than a quarter of a century. Leading the way is City of London (LSE: CIN.L - news) , having held or maintained its dividend for 45 consecutive years. It is followed by Alliance Trust, while F&C Global Smaller Companies, Foreign & Colonial and Brunner, JPMorgan Claverhouse and Witan have not cut dividends in 30-plus years.
But investment trusts don't just offer big general funds. There are also specialist trusts investing in everything from VCTs and private equity in the UK to Japanese smaller companies. The Association of Investment Companies website ( theaic.co.uk ) has details of all trusts, plus information on past performance.
It is worth remembering that many of our most successful fund managers also run virtually identical investment trusts, but often at up to a third of the normal fee. Neil Woodford, for example, who runs Invesco Perpetual's mammoth £8bn Income Fund, also runs the Edinburgh Investment Trust. This has a similar investment mandate, but investors pay just a 0.6pc annual fee, rather than the 1.5pc annual charge (plus a potential 5pc upfront fee) when they buy his unit trust.
Other star managers including Harry Nimmo, who runs Standard Life (LSE: SL.L - news) 's UK smaller companies fund, Evy Hambro (BlackRock (NYSE: BLK - news) 's World Mining fund), and Alastair Mundy (Investec (LSE: INVP.L - news) 's UK Special Situation fund) have "mirror" investment trusts that have performed better and charge less.